P/B (Price-to-Book)

P/B in its simplest form

Price-to-Book (P/B) is market value divided by equity (book value). If a company is worth 1 000 MSEK on the stock exchange and has 500 MSEK in equity, P/B = 2. You pay 2 kronor for every krona the company's net worth is booked at. P/B answers the question: 'Am I paying a premium or a discount for the company's assets minus liabilities?'. P/B < 1 means you are buying the assets more cheaply than they are booked — a theoretical buying opportunity (though often a warning, as we shall see). P/B > 5 means the market is pricing in large future values that do not show in the accounting — intangible assets, brand, moat, growth expectations. The AKM1 scale: P/B < 1 = score 5; 1-1,5 = score 4; 1,5-3 = score 3; 3-5 = score 2; > 5 = score 1.

📖 DEFINITION

P/B = Market value / Equity. Alternatively: Share price / Book value per share. Measured as a multiple. P/B 1 = you pay book value; P/B 0,8 = 20% discount; P/B 2 = 100% premium.

When P/B is relevant

✓ TIP

P/B suits companies where the balance sheet represents the true value: banks, real estate, holding companies. For service and software companies where the value is in brand/customer relationships/R&D (not booked) P/B is misleading.

Why P/B < 1 is not always a buy

An intuitive thought: if P/B < 1, I am buying assets more cheaply than they are worth — buy! Reality is more complex. P/B < 1 means the market prices the company below its book value. This can have three causes. First: the assets are overvalued in the accounting. Classic for industrial companies with old goodwill that does not generate a return. A company that has acquired competitors and booked 500 MSEK of goodwill that later proved worthless — book value is 1 000 MSEK, but the true value is 500 MSEK. P/B 0,7 is then actually P/B 1,4 on true values — not cheap. Second: the company is burning cash. If ROE is low (below the cost of equity ~8-10%) the company destroys value every year. P/B < 1 reflects the market expecting continued value destruction. Third: an industry in structural decline. Print media, traditional telecom hardware, fossil energy production — booked assets will become idle before they are depreciated. P/B < 1 is then fair, not a buy. Learn to distinguish: P/B < 1 + ROE > 12% + positive cash flow = buy. P/B < 1 + ROE < 5% + negative cash flow = value trap.

⚠️ WARNING

P/B < 1 + low ROE + negative cash flow = value trap. The market is pricing correctly — the assets are not worth book value due to impending impairments or low return.

⚡ KEY INSIGHTS P/B = Market value / Equity — measures the pricing of net worth Suits: banks, real estate, holding companies (where the balance sheet = true value) P/B < 1 is not always a buy — can be a value trap (overvalued assets, low ROE) Always interpreted together with ROE: high ROE justifies a high P/B 2

ROE — return on equity

Return on Equity (ROE) is net profit divided by equity. It measures how much profit the company creates per krona of equity. A company with 100 MSEK of equity and 15 MSEK of profit has ROE 15% — every krona of owner's capital generates 15 öre of profit per year. ROE is the direct link to P/B: if the company has high ROE it justifies a high P/B because every krona of equity is more valuable (it generates more return). Warren Buffett looks for companies with ROE > 15% over time — these are his 'wonderful companies'. Graham's logic: if the cost of equity is ~10% (risk-free interest rate + risk premium), companies with ROE > 10% should trade at P/B > 1 (they create value). Companies with ROE < 10% should trade at P/B < 1 (they destroy value). This adjustment — P/B in relation to ROE — is the core of P/B analysis.

📖 DEFINITION

ROE = Net profit / Equity × 100. ROE > cost of equity (typically 8-12%) = value-creating. ROE < cost = value-destroying. P/B should be related to ROE.

P/B-adjusted multiple — P/B / ROE

One of the analyst's best adjusted multiples is P/B / ROE. It says: 'How much am I paying per percentage point of return on equity?'. Rule of thumb: P/B / ROE < 0,15 = cheap; 0,15-0,25 = normal; > 0,25 = expensive. Example: Company A P/B 2,5, ROE 18% → 2,5/18 = 0,14 (cheap). Company B P/B 1,2, ROE 5% → 1,2/5 = 0,24 (normal-expensive). Company C P/B 0,8, ROE 4% → 0,8/4 = 0,20 (normal, despite low P/B). Conclusion: Company A with high P/B is actually cheaper than Company B with low P/B — due to a much higher ROE. Company C looks cheap on raw P/B but is normal adjusted for ROE. This illustrates why professional analysts NEVER look at P/B alone. A company can have 'low P/B' and still be expensive adjusted for return; a company can have 'high P/B' and still be cheap.

💡 INSIGHT

P/B / ROE < 0,15 = buy signal; > 0,25 = sell signal. This adjustment transforms P/B from a crude multiple into a useful 'price per unit of return'. Always use it when comparing companies.

DuPont decomposition of ROE

ROE can be broken down into three components via the DuPont formula: ROE = Profit margin × Capital turnover × Financial leverage. Profit margin = net profit / revenue. Capital turnover = revenue / total assets. Financial leverage = total assets / equity. This breakdown reveals the SOURCE of ROE — and its quality. Three types of ROE. First: high-quality ROE driven by a high profit margin (pricing power, moat). Apple: 25% profit margin × 1,0 capital turnover × 2,5 leverage = 62% ROE — highest quality. Second: capital-efficient ROE driven by high capital turnover (low capital requirement). Walmart: 3% profit margin × 2,5 capital turnover × 2,5 leverage = 19% ROE — solid. Third: debt-driven ROE driven by high financial leverage. Banks: 15% profit margin × 0,1 capital turnover × 10 leverage = 15% ROE — risky. As an analyst: high-quality ROE (margin-driven) justifies the highest P/B; capital-efficient ROE justifies a medium-high P/B; debt-driven ROE justifies the lowest P/B (due to risk). A company with P/B 5 and ROE driven by margin = buy; a company with P/B 5 and ROE driven by debt = avoid.

✓ TIP

Use the DuPont decomposition to understand the SOURCE of ROE before judging whether P/B is justified. High ROE driven by margin = premium P/B justified; high ROE driven by debt = risk, low P/B justified.

⚡ KEY INSIGHTS ROE = Net profit / Equity — return on owner's capital P/B / ROE < 0,15 = cheap; > 0,25 = expensive (adjusted for return) DuPont: ROE = Profit margin × Capital turnover × Financial leverage Premium P/B is justified by margin-driven ROE; low P/B is justified by debt-driven ROE 3